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Briefly Noted

Step-Up Value and Inherited Assets

In last month’s Briefly Noted discussion about the lack of an estate tax, we made an error in discussing the tax basis for selling inherited assets [“The Lack of an Estate Tax,” April 2010 AAII Journal]. Specifically, we said that “inherited property is not ‘stepped-up.’” That was not completely correct.

If property is inherited in 2010 and subsequently sold, the tax basis for calculating any gain is based on two numbers. The first is the price paid by the deceased. The second is a step-up value of $1.3 million. (Surviving spouses are eligible for an additional $3 million, bringing the total step-up value to $4.3 million.)

For example, say the deceased purchased an asset for $10 million and transferred it to his spouse at death. The spouse accepts an offer to sell the asset for $20 million. The tax basis for the asset would be the $10 million purchase price + a $1.3 million step-up value + an additional $3 million step-up value for spouses, for a total tax basis of $14.3 million.

Note that heirs must use the original cost plus the step-up value for calculating the cost basis and this applies only in 2010 and under current law. Previously, heirs could use the fair market value at death for determining the value of an asset.

Thanks to Mitchell Freedman for clarifying the rule.

FINRA Is Looking for Arbitrators

The Financial Industry Regulatory Authority (FINRA), the nation’s largest independent regulator for all securities firms doing business in the U.S., operates the largest forum of dispute resolution for the securities industry in the country. This forum facilitates the resolution of monetary, business and employment disputes between investors, securities firms and employees of securities firms, and seeks to deliver fairness, integrity and trust to the industry and investors.

FINRA is now recruiting fair-minded professionals, such as attorneys, accountants, business professionals and others, to serve as arbitrators in their forum.

If you would like to become a FINRA arbitrator, and you have at least five years of professional experience in your field, you may be eligible to apply. For more information, call 212/858-4106, or go to www.finra.org/ArbitrationMediation. Please note that a fee is required to apply.

Source: Financial Industry Regulatory Authority, www.finra.org.

Supreme Court Rules on Fees

Mutual fund fees and investment advisory fees in general were the subject of a Supreme Court ruling in late March in the case of Jones v. Harris Associates.

The plaintiffs alleged Harris Associates, which managed the Oakmark Funds, charged fees that were “disproportionate to the services rendered” and “not within the range of what would have been negotiated at arm’s length in light of all the surrounding circumstances.” At issue was the fact that the plaintiffs were charged fees that were nearly twice as high as those charged to institutional clients.

Though nobody likes being charged a higher fee than another client, the Supreme Court said that differences in services are a valid reason for a tiered structured. Specifically, “the [Investment Company Act of 1940] does not necessarily ensure fee parity between mutual funds and institutional clients.” In other words, advisors can charge individual investors higher fees than they charge institutional clients.

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In terms of whether the fees were reasonable, the Court upheld the Investment Company Act of 1940 and cited Gartenberg v. Merrill Lynch Asset Management (“Gartenberg”). In doing so, the Court said deference should be given to a fund’s board of directors in determining fees. The Court also said that the plaintiff must provide burden of proof to show that the fees are too high. (We should point out that though the decision was unanimous, Justice Clarence Thomas did issue a separate opinion specifically stating that the Court did not affirm the Gartenberg standard.)

The net effect of the ruling is that investors will need to continue to rely on their own analysis of fees and market forces to keep fund expenses down. Specifically, you should continue to be cognizant of all fees paid and to constantly ask whether the performance and service you are receiving justify the fees.

Sources: AAII Investor Update weekly e-mail; U.S. Supreme Court.

Institutional Investors Are Upbeat

Two surveys signaled optimism on the part of institutional investors as of press time.

The State Street Investor Confidence Index reached 108.0 in March, up 5.4 points from February. The March reading was the highest the index has been in five months. (The index reached 122.8 in August 2009, and fell as low as 82.1 in October 2008.) The index determines sentiment by analyzing buying and selling patterns.

Increased bullishness among Asian institutional investors was the primary reason for the recent improvement, though American institutional investors were also more positive.

Ken Froot, who developed the survey, observed that investors were focused on the macro-economic outlook and what it means for valuations. He further noted that institutional investors worldwide have been “consistent buyers in many markets.”

Separately, the April BofA (Bank of America) Merrill Lynch Survey of Fund Managers found that the “number of investors taking ‘above normal’ risk in their portfolios is at its highest since January 2006.” The survey polled 197 fund managers worldwide.

A net 52% of respondents were overweight equities, which represented a sharp increase from February. Many also increased their exposure to cyclical stocks. It should be noted that 43% of respondents said increased capital spending among corporations was a priority for them, the largest amount to say this since June 2006.

Two of the factors identified by the survey as influencing strategies were profitability and the Fed. Significantly more respondents thought corporate earnings would show double-digit percentage growth over the next 12 months (71% in April’s survey versus 53% in March’s survey). As far as Fed policy, 42% predicted the first rate hike would not occur until 2011.

Institutional investor surveys are useful for gauging the mood of the market and helping to determine how professional money managers are allocating their funds. Like any survey, however, they are merely a snapshot of a certain point in time. As a result, information from surveys—be it an investor, consumer or industry survey—should be treated as just one part of a broad analysis, not the sole reason to buy or sell an investment.

Sources: State Street Investor Global Markets, www.statestreet.com; and Bank of America/Merrill Lynch, www.bankofamerica.com.

Quick Financial Management Tips

The May 2010 issue of Kiplinger’s listed several ways to better manage your finances. The magazine said each step could be accomplished in 15 minutes or less. Though we did not put a timer to each task, there were many good ideas.

Here are some of our favorites (along with some additional suggestions from us):

  • Copy everything in your wallet: Kiplinger’s is not the first source we’ve seen recommending this, but it is good way to protect yourself in the event of a stolen or lost wallet. Be sure to copy the front and back of all cards, especially since the customer service number is typically on the back of credit cards.
  • Rent a safe-deposit box: A safe-deposit box provides safety against a fire or theft. Kiplinger’s suggests putting all documents in a plastic bag as well, in case the bank floods. (We also suggest keeping a copy of important electronic files in the box.)
  • Take an X-ray of your fund portfolio: Analyze the mutual funds in your portfolio to ensure that they are not holding the same stocks. (It is also a good idea to check any exchange-traded funds and include any individual stocks you own in the analysis.)
  • Investigate your broker: Run a background check of your broker at www.finra.org/brokercheck. The report will show the broker’s qualifications and will list any regulatory action that has been taken against them in the past.
  • Check up on your credit: This is something that should be done every year. If there is an error, file a dispute with the reporting agency and call the creditor. Higher credit scores mean lower interest rates.
  • Buy Treasuries straight from the source: Commissions on Treasury bills, notes and bonds can be completely avoided by purchasing government debt directly from the Treasury department. Just visit www.treasurydirect.gov and set up an account.
  • Calculate your future Social Security benefits: The Social Security Administration has an online tool at www.ssa.gov that shows an estimate of benefits based on your actual salary. This is useful information to have when determining how to save for retirement.
  • Keep the bling in your ring: If you or your spouse wear a ring with a diamond or other precious stone, have a jeweler check the prongs. Even one loose prong increases the risk of the diamond falling out.
  • Leave your cash to the ones you really love: Check the beneficiary designations on all of your investment accounts, including any mutual funds. You want to make sure that the names and contact information are correct and up to date.

Source: May 2010 Kiplinger’s Personal Finance.


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